Investment markets and key developments over the past week
Share markets rose over the last week as progress continued in reopening economies supporting perceptions that economic activity may have passed the worst. US unemployment rose to 14.7%, the highest since in the aftermath of the Great Depression but it had largely been discounted and wasn’t quite as bad as feared. For the week US shares rose 3.5%, Eurozone shares rose 0.1%, Japanese shares gained 2.9%, Chinese shares rose 1.3% and Australian shares rose 2.8%. Australian shares were helped by the positive global lead and the Government’s move to reopen the economy which saw all sectors gain but with very strong gains for IT, materials, real estate and energy shares. Bond yields rose, as did oil, metal prices and iron prices. The Australian dollar also rose despite a rise in the US dollar.
There was nothing really new of note over the past week in relation to coronavirus. New global coronavirus cases have been trending sideways for more than a month now.
New cases in Europe remain in a clear downtrend and the US looks to have peaked but various emerging/less developed countries are driving a still rising trend in the rest of the world. This includes Brazil, India and Russia.
Australia is continuing to see a low number of new cases, but still has some problems with clusters.
More countries easing lockdowns. In Europe the progression towards reopening is consistent with the clear downtrend in new cases. Reopening is probably more of a risk in the US though given the absence of a clear downtrend in new cases (outside of New York) and partly reflects political pressure from President Trump. However, if the easing of the lockdown in the US is managed sensibly in line with the three phased Opening Up America Again program that is conditional on testing, contact tracing, etc, as released by the Administration last month then a “second wave” should be avoided. NZ looks likely to further ease its lockdown too. Reflecting the move towards reopening we are starting to see a migration in countries from severe to intermediate lockdowns.
Australia is reopening with a three staged easing of restrictions with the aim of having much of the economy operating again by July in a Covid-safe environment. Each state and territory will move at their own pace. The reopening is supported by the sharp decline in the number of new cases along with various criteria around testing, contact tracing, the health care system etc being met. Each phase looks like it will be around three weeks apart with authorities monitoring health risks around the virus before progressing to the next stage. Step 1 can see gatherings of up to 10 people outside homes and schools, shops, small cafes and restaurants (with 10 people) can reopen along with playgrounds, libraries, golf courses and local and regional travel will be allowed. Step 2 will see most businesses reopen including cinemas and galleries with gatherings of up to 20 people and some interstate travel but with people still working from home if it works. Step 3 will see all return to work, gatherings up to 100 people, all interstate travel and possible travel to NZ, Pacific islands and international student travel. While it will be gradual and entail costs for businesses around hygiene and distancing, it is consistent with our view that April or May will be the low point in economic activity with a gradual economic recovery underway through the second half.
While full international travel will be the last thing to reopen (the PM said “not in the foreseeable future”) note that the main reason for the slump in the Australian economy is because domestic demand has been locked up and in any case Australia has a tourism trade deficit with the rest of the world so will perversely benefit if international tourist travel remains barred. That said with Australia joining a First Movers Club of countries (including Austria, Greece & NZ) that have been successful in controlling the virus it’s possible that travel to them may return sooner. Step 3 will also consider the return of international student travel which is important because Australia has a 2% of GDP trade surplus in education.
Economic data globally and in Australia has generally continued to worsen but actual economic activity may have hit bottom. Given the lagged nature of most data we will likely be seeing bad news for a while yet with June quarter GDP data which is expected to show a 10% plus slump in the US, Europe and Australia not due for another three months and not due till early September in Australia. However, there are signs from high frequency data that activity may have hit bottom and markets will mostly focus on this. Our weekly economic activity trackers for the US and Australia based on high frequency data for things like restaurant bookings, confidence, retail foot traffic, box office takings, credit card data, mobility indexes & jobs data are showing signs of stabilisation.
In the short-term shares are still at risk of a pull back after the strong run up since 23rd March. Trying to time this lately has been very difficult though and it may turn out to be no more than a consolidation. But providing we are right and shutdowns ease from now resulting in April or May proving to be the low point in economic activity then given the massive policy stimulus already seen shares should be higher on a 12-month outlook. There are three big risks to keep an eye on over the next few months:
- First – a second wave of coronavirus cases. This should be manageable with ramped up testing, quarantining and contact tracing and a phased conditional reopening of economies, but the US is perhaps most at risk.
- Second – collateral damage from the shutdowns in the form of permanent company closures and rising defaults. So far so good but its early days and this will be critically important in terms of the speed of the recovery.
- Third – an escalation in US/China tensions. President Trump seems to have backed away from threats to impose more tariffs on China (provided it sticks to the trade deal – on which Mr Trump has expressed doubt in contrast to comments from US officials) or other sanctions in relation to the origin of the virus issue but this issue still has a long way to play out with Mr Trump keen to shift blame over the impact of the virus on the US in the run up to the November election.
The German Constitutional Court’s ruling on the legality of the ECB’s QE program wasn’t as bad for the ECB as it could have been but still poses a problem for it. On the one hand the Court did not find that QE violated the prohibition on monetary financing of budget deficits but it has required that the ECB demonstrate that its QE program is “proportionate” to its mandate allowing for side effects on fiscal policy, otherwise the Bundesbank will not be able to participate in it . This should be possible for the ECB to do but it and its big new Pandemic Emergency Purchase QE Program could face new legal challenges. All of which risks greater scrutiny and less flexibility to deal with new problems. Fortunately, any challenge to the PEPP will likely not impact till after the current crisis is over and the Court ruling does increase pressure on the EU to deploy a stronger fiscal response and resolve the issue around common bonds. All of which explains why the Euro fell, and Eurozone bond yields rose, but not by that much over the last week.
In Australia, as widely expected the RBA made no further changes to monetary policy. Having eased significantly back in March it is now in wait and see mode but remains committed “to do what it can to support jobs, incomes and businesses”. With the cash rate at the lower bound it won’t be cut further and with full employment and the inflation target a long way from being achieved it won’t be raised any time soon either. We expect the cash rate to be stuck at 0.25% for at least the next three years.
Meanwhile, the RBA’s baseline economic outlook sees a 10% hit to GDP in the first half of the year with around a 6% decline in GDP through 2020, followed by 6% growth next year, unemployment to peak at around 10% in coming months before falling to around 7.5% by the end of next year and inflation going negative in the current quarter and remaining below 2% over the next few years. These forecasts are similar to our own although we see a slower decline in unemployment and a lower profile for inflation than the RBA. Given the uncertainty around the length of the shutdown the RBA also considers upside and downside scenarios. In particular, it notes that a faster recovery would be possible if the containment measures are mostly phased out in coming months rather than by the end of the September quarter as it assumes in its baseline scenario. With the Government appearing to move down this faster reopening path a stronger recovery is possible. Given the damage to the economy though we will still assume something closer to the baseline.
Major global economic events and implications
US economic data remains bleak. The non-manufacturing conditions ISM plunged in April (albeit by less than expected), the trade deficit widened, a Fed survey of bankers showed a tightening in lending standards and less demand for loans and payroll employment plunged by a record 20.5 million in April pushing the unemployment rate to 14.7%, which is the highest since in the aftermath of the Great Depression. The combination of unemployment and underemployment surged to 22.8%. Women, young and less educated workers were hit the hardest reflecting the slump in jobs being concentrated in sectors like leisure and retail. Horrible as these numbers are, they had been anticipated by investment markets and weren’t quite as bad as had been feared. It’s also worth noting that 80% of the unemployed were classified as being on “temporary layoff”, which may augur well for re-employment as the employer/employee relationship has not been severed. Unemployment is still likely to rise a bit further in May, but declining jobless claims suggest that the Paycheck Protection Program may be starting to help, and a reopening of the economy should see many return to work in June.
The March quarter US earnings reporting season is now 87% done and is seeing only half of companies report a rise in earnings with profits down in energy, basic materials, industrials, consumer goods and services and financials. Earnings look to have fallen 13%yoy in the March quarter with the consensus pointing to a 40%yoy fall in the June quarter.
Chinese April exports were strong, but imports were weak which is surprising given a gradual return of domestic demand but falling global demand. Expect much weaker exports in May.
Australian economic events and implications
Australia saw a record 8.5% surge in retail sales in March and a record $10.6bn trade surplus, but lots of other data is consistent with a big contraction in the economy this quarter. Real retail sales rose 0.7% in the March quarter and net exports or trade looks likely to contribute around 0.3 percentage points to March quarter GDP growth. While it’s possible, this probably won’t be enough to stop a contraction in March quarter GDP given a fall in car sales and consumer services, but it should keep it moderate at around -0.2%, ahead of a 10% or so plunge in the June quarter. The surge in retail sales was driven by panic buying and so will reverse from April to be combined with a slump in discretionary spending to probably result in a record fall in retail sales.
Meanwhile, a range of other data highlights the impact of the shutdown on the economy with car sales down 52% in April, ANZ job ads down 53%, ABS payroll data indicating a 7.5% fall in payrolls since mid-April (which according to the ABS suggests a 650-700 thousand fall in employment) and over 70% of business seeing reduced cash flows. Building approvals only fell 4% in March but are likely to fall more in subsequent months.
The good news though is that so far over 720,000 businesses have applied to the JobKeeper program covering around 4.7 million workers. And while it’s still very weak the ANZ Roy Morgan weekly consumer confidence index has now risen for 5 weeks in a row.
Overall, there is nothing here to change our view that the economy contracted by around 10% or so in the current quarter, April is likely to have been the low point and that with an easing in the lockdown the economy will grow in the second half.
Finally, the Melbourne Institute’s Inflation Gauge for April showed a fall to 1.2%yoy, highlighting that the shutdown is more deflationary than inflationary.
What to watch over the next week?
Markets will likely remain focussed on continuing evidence that the number of new Covid-19 cases is slowing and on progress in easing lockdowns. Economic releases will continue to show the impact of coronavirus shutdowns, but markets will likely be on the lookout for signs of improvement.
In the US, expect a sharp fall in small business confidence (Monday), 10 to 15% falls in retail sales and industrial production (Friday) and a big drop in job openings and hiring (also Friday). However, the New York Fed’s manufacturing conditions index is expected to improve a bit for May after a sharp fall into April. CPI inflation for April is expected to plunge to just 0.5% year on year from 1.5% in March.
Chinese economic activity data is expected to confirm a further gradual improvement in economic momentum for April with industrial production growth rising to 1.5% year on year (from -1.1%), retail sales growth improving to -5% (from -15.8%) and investment growth improving to -9% (from -16%). Credit and money supply growth is expected to remain strong.
In Australia, the main focus will be on jobs data for April to be released Thursday which is expected to show a record 750,000 drop in employment in response to the shutdown resulting in unemployment rising to around 10%. This is consistent with a collapse in job ads, survey hiring plans and ABS payroll data with a decline in workforce participation partly muting the rise in unemployment. Were it not for the JobKeeper wage subsidy program unemployment would likely be nearer 15%. In other data, expect the NAB business survey (Tuesday) to show a further decline in business conditions but a slight bounce in business confidence after the plunge to -65.6 in March, consumer confidence for April to rise slightly consistent with a rise in the weekly ANZ/Roy Morgan consumer confidence index and wages growth for the March quarter to have remained around 0.4%qoq or 2%yoy. The Treasurer will also provide a statement to parliament on Tuesday regarding the impact on the economy from the shutdown and the Government’s response but it’s doubtful this will add much to a speech he made in the last week.
Outlook for investment markets
After a strong rally from March lows shares are vulnerable in the short term to a pull back or consolidation. But on a 12-month horizon shares are expected to see good total returns helped by an eventual pick-up in economic activity and massive policy stimulus.
Low starting point yields are likely to result in low returns from bonds once the dust settles from coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to continue benefitting from the search for yield but the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.
The Australian housing market has slowed in response to coronavirus. Social distancing has driven a collapse in sales volumes, and a sharp rise in unemployment, a stop to immigration through the shutdown and rent holidays pose a major threat to property prices. Prices are expected to fall between 5% to 20%, but government support measures including wage subsidies along with bank mortgage payment deferrals along with a plunge in listings will help limit falls as will a reopening of the economy in the months ahead.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
The hit to global growth from Covid-19 and its flow on to reduced demand for Australian exports and lower commodity prices still risks pushing the A$ lower in the short term. But expect a rising trend once the threat from coronavirus recedes, particularly with the US expanding its money supply far more than Australia is via quantitative easing and with China’s earlier recovery likely to boost demand for Australian raw materials.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economics and Chief Economist
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